Video Transcript: Lesson 29

Okay, continuing along in Unit 10, this is Lesson Two. We're going to discuss tax cuts and national savings. So, if the government is spending more than it  receives in tax revenues, then it is obviously running a deficit because that is the way the government brings in its revenue is through taxes. So, if it spends more  than it receives in tax revenues, obviously it's running a deficit. If we look at its  spending and it's less than it receives in tax revenues, we're running a surplus.  So, if we're bringing in more tax revenues than we are spending out, we are  running an economic surplus. So, national savings is the combined savings of  the government and the private sector. If the government is running a deficit,  which you'll see private savings minus the government deficit, if the government  deficit is larger than private savings, we're going to be running a deficit. And if  the government is running a surplus, national savings will equal private savings  plus the surplus. Right. So here you'll see in the first example or the first  equation that the private savings is the you know everything that has been  brought in by the private sector, and then you're going to subtract out the  government deficit. That'll give you the national savings rate. Versus if you have  the government running a surplus, you'll have private savings plus the  government surplus, and that'll be the national savings rate. These are just two  different ways of saying the same thing because, by definition, the government  surplus equals minus the government deficit. What happens if the government  cuts taxes? If there are no associated changes in government spending, then  tax cuts translate dollar for dollar into the government budget. $1 million worth of tax cuts will increase the deficit or decrease the surplus by exactly $1 million. So even though a tax cut of $1 increases private savings by $1 minus the marginal  propensity to consume. So let's say consumption is zero, and you know you  have a savings of $1. So then now you're in equilibrium. It costs the government $1, right? Because they gave you that tax cut. The next effect to begin with is to  reduce the national savings by an amount equal to the marginal propensity to  consume, right? So if the tax cut exceeds an increasing income, there is  additional savings resulting from the multiplier process. Still, we expect the  overall effect to decrease the national savings. For example, consider consider  the Kennedy tax cut. Right, taxes were cut by 10 billion. The resulting change in  income was roughly 20 billion, with a marginal propensity to save equal to 0.07.  The offsetting increase in private savings would have been 1.4 billion. Evidently,  the result was a large decrease in national savings. Here we see one of the  biggest problems with tax cuts. They are attractive in the short run because they stimulate aggregate demand and increase output. They are also attractive  politically for obvious reasons. People have more money. Unfortunately, they  have the adverse long-run consequence of reducing national savings. When  national savings decreases, the economy does not build up its capital stock so  quickly, so future living standards are lower than they would otherwise be. So  over the long run, you know we're going to have these tax cuts, but you may run

short of being able to break even. So you'll run a deficit in the government, and  therefore the larger deficits you have because of less tax receipts, your national  savings rate over the longer term will diminish.